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Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1.
November 29 - 30, 2014. Hotel Putra...
Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1.
November 29 - 30, 2014. Hotel Putra...
Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1.
November 29 - 30, 2014. Hotel Putra...
Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1.
November 29 - 30, 2014. Hotel Putra...
Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1.
November 29 - 30, 2014. Hotel Putra...
Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1.
November 29 - 30, 2014. Hotel Putra...
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Have Islamic Microfinance Institutions In Indonesia Implement Risk Management?

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  1. 1. Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1. November 29 - 30, 2014. Hotel Putra, Kuala Lumpur, Malaysia. ISBN 978-967-11350-4-4 109 HAVE ISLAMIC MICROFINANCE INSTITUTIONS IN INDONESIA IMPLEMENT RISK MANAGEMENT? Muh Juan Suam Toro Center of Islamic Economics Study Universitas Sebelas Maret, Surakarta, Indonesia Email: mjuanst@yahoo.com Arum Setyowati Center of Islamic Economics Study Universitas Sebelas Maret, Surakarta, Indonesia Email: arumsetyowati@yahoo.com Arifuddin Center of Islamic Economics Study Universitas Sebelas Maret, Surakarta, Indonesia Email: arifarifin81@gmail.com ABSTRACT Banking in Indonesia is highly regulated by Bank Indonesia as the central bank with the aim to prevent the failure of the banking system and to guarantee the public funds are in the safe hands. At the micro level, there are many financial institutions that serves as intermediary institution that operates like a bank, but not under the supervision of the central bank. In addition, the rapid increase in the number of Islamic microfinance institutions (Islamic-MFI) in response to the desire of the majority moslem population of Indonesia raised the question whether they apply the principles of prudential banking. This study aimed to identify the risk management practices applied by Islamic microfinance institutions and examines how the impact of these practices on financial performance. The population of this research is Islamic-MFI. The sample of this research is Islamic microfinance institutions in the form of Baitul Maal wal-Tamwil (BMT) and the Koperasi Jasa Keuangan Syariah (KJKS) in the area of Regency of Klaten, Sukoharjo, Boyolali, and Karanganyar, Jawa Tengah Province. Descriptive analysis and regression analysis were used to meet the research objectives. Descriptive analysis is used to describe the extent to which forms of risk management practices carried out by Islamic microfinance institutions and regression analysis were used to analyze the relationship between risk management’s understanding, identification, assessment, and monitoring and risk management practices in Islamic-MFIs. The result showed that Islamic-MFIs have understood, able to measure, and monitor risk management, but the ability to perform risk identification are still weak. The second result showed that Islamic-MFIs have implemented risk management practices and credit analysis. There are relationships between ability to understand, carry out assessment, and monitoring of risk management and risk management practices, but no relationships for risk identification. Risks type faced by Islamic-MFI are credit risk, debt risk, liquidity risk, reputation risk, and interest rate risk. Keywords: risk management, Islamic microfinance institution, financial performance BACKGROUND The study of the microfinance industry has recently become interesting to study because of the fact that microfinance institution (MFI) have some role in stimulating the economy through support for small and medium enterprises (SMEs) and improve the welfare of society. MFI is described to overcome poverty through capital funding for businesses organized by low-income communities. By MFI, the growth of micro/society business will be able to survive and continue to grow. In Indonesia, the MFI is usually found in the form of cooperative institution. Cooperative is an entity that consists of a single person or a legal entity with the bases of cooperative activities based on the principles of cooperation as well as economic movement based on the familyhood principle. Some types of MFIs in Indonesia are: 1. Saving and load cooperative 2. Savings and Loan Unit
  2. 2. Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1. November 29 - 30, 2014. Hotel Putra, Kuala Lumpur, Malaysia. ISBN 978-967-11350-4-4 110 3. Community’s Funds and Credit Institution 4. Sharia Cooperative 5. Credit Cooperatives or Non Goverment Organizations Baitul Maal wat-Tamwil (BMT) is a type of MFIs that implement the collection and distribution of funds on the principles of Islam (sharia principle) basis. BMT legal entities are Sharia cooperative called Koperasi Jasa Keuangan Syariah (KJKS). In this study, BMT hereinafter referred to Islamic microfinance institution (Islamic-MFI). According to data from the financial services authority in Indonesia, called Otoritas Jasa Keuangan (OJK), Islamic- MFI currently is estimated more than 500,000 cooperatives with total assets size in trillions. Until now, only about 200,000 cooperatives with total assets of more than 125 trillion recorded in the Department Of Cooperatives. As commercial banks, Islamic-MFI has a goal of collecting and distributing funds from surplus people/organization to the deficit people/organization. This business mechanism functions encourage Islamic-MFI to give attention to risk management in its operational activities. Risk is the potential loss due to the occurrence of a specific event (events). Risk management is a set of methodologies and procedures, which is used to identify, measure, monitor, and controlling risk arising from the operations of the Bank (Bank Indonesia, 2009). As has been mentioned earlier that the collection and distribution of funds from Islamic-MFI has considerable exposure to risk, then Islamic-MFI should also do risk management practices for the purpose of securing funds for its clients, in other word, securing the society’s fund. Bank Indonesia has required commercial banks and Islamic business units to implement risk management practices at all operations. Types of risks that must be managed include: Credit Risk, Market Risk, Liquidity Risk, Operational Risk, Legal Risk, Reputational Risk, Strategic Risk, Compliance Risk, Yield Risks, and Investment Risk. While the implementation of risk management, some steps must be taken: risk identification, risk measurement, risk monitoring and risk control. This study aims to investigates risk management practices conducted by Islamic-MFI. Some of the questions raised in this study are: a. Have Islamic-MFIs adopted the practice of risk management (understanding risk management, risk identification, risk assessment, risk monitoring, and credit risk analysis)? b. What type of risk faced by Islamic-MFI? LITERATURE REVIEW MFI is an that run the bank's business activities as collecting and distributing funds from surplus entities to the deficit entities, although to date the legal forms commonly used in Indonesia are cooperative. In 2013, the Indonesian government has passed a regulation for microfinance institution to regulate the operasion of MFI In Indonesia, since 2003, through regulation by Bank Indonesia (central bank), requires all commercial banks to implement risk management in their business activities. This suggests that concerns about the practice of risk management in the banking industry is very important. Some research on bank risk management practices have been carried out, including studies conducted Al Tamimi and Al Mazrooei in 2007 were conducted in the United Arab Emirates (UAE). This study compared the risk management practices conducted foreign banks and domestic banks. The results show that there are significant differences in risk measurement and monitoring of national banks and foreign banks. While the identification of risk, risk management practices, and credit risk analysis is not a significant difference. In this study also indicated that foreign exchange risk, credit risk, and operational risk is the risk types most frequently encountered. Other research conducted by Syafique et al. (2013) who examine differences in the risk management practices between Islamic financial institutions and conventional financial institutions in Pakistan. The results indicate that there are six main types of risks faced by financial institutions in Pakistan namely credit risk, equity investment risk, market risk, liquidity risk, rate of return risk; and operational risk. In the practice of risk management, there is no difference between Islamic and conventional financial institutions in Pakistan. Another study conducted by Tafri et al. (2011). This study compared the risk management practices of Islamic banks and conventional banks in Malaysia. The results indicate that there are significant differences in the results of measuring credit risk and operational Islamic banks and conventional banks in Malaysia. Other findings indicate that the risk management and risk management systems in banks Islam inadequate.
  3. 3. Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1. November 29 - 30, 2014. Hotel Putra, Kuala Lumpur, Malaysia. ISBN 978-967-11350-4-4 111 Khalid and Amjad (2012) measured the risk management practices of Islamic banks in Pakistan and found that a good understanding of risk management in Islamic banking in Pakistan and all aspects of risk management has positive relationship with the practice of risk management. Understanding and monitoring risk are found as two most influential aspects of risk management practices in Pakistan. This study showed results consistent with the research of Al Tamimi and Mazrooei (2007). Husain and Al Ajmi (2012) in his study conducted in Bahrain, stated that the banker in Bahrain are aware of the importance of risk management practices in reducing costs and improving performance. There are three main types of risks faced by banks in Bahrain, namely credit risk, operational risk, and liquidity risk. The practice of risk management in the banking sector in Bahrain is affected by variables such as the understanding of risk management, risk identification, risk measurement, monitoring and risk management. This study also found no difference between the bank's risk management practices of conventional and Islamic banks. RESEARCH DESIGN Researchers used a questionnaire to determine the risk management practices have been implemented by Islamic-MFI. The original question developed by Al tamimi and Al Mazrooei (2007) consists of 43 questions and divided into eight questions to determine: a) 8 items for understanding of risk and risk management, b) 5 items for risk identification c) 7 items for risk assessment/measurement, d) 6 items for risk monitoring e) 9 items for risk management practices f) 7 items for credit risk analysis performed To determine the types of risks faced by Islamic-MFI, researchers gave an open answer to the manager/middle staff consisting of 10 risks faced by Islamic-MFI, namely credit risk, operational risk, liquidity risk, legal risk, debt risk, interest rate risk, reputation risk, price risk, strategic risk, and the competition risk. These types of risk is the kind of risk that must be considered Bank Indonesia, as a rule and obligation for commercial banks and Islamic business units of commercial banks. The research design used in this study is an exploratory research. Exploratory research aims to understand the characteristics of the phenomenon or problem under study because only few literatures that addresses the issue of risk management practices and risk management methods conducted by Islamic-MFI. The sample in this study was 30 Islamic-MFI in the form of BMT and KJKS that spread in Solo residency (Karanganyar, Boyolali, Sukoharjo, Klaten and Surakarta). The sampling method used in this study was a convenience slampling. This sampling method is choosen due to the limited information on the number of Islamic- existing MFIs. In addition, the owner/manager of MFI usualy not transparent in providing information for researchers. The data analysis employed in this research is descriptive statistics and univariate analysis. The method of analysis used in this study using descriptive statistics and univariate analysis to provide information relating to the extent to which risk management practices has been performed Islamic-MFIs and what risks faced by the Islamic- MFIs. RESULT AND DISCUSSION Results of descriptive statistics in Table 1 shows that the respondents answers for Likert scale (1=very disagreed, 7=very agreed) used to measure the agreement of statement for dimensions of risk management are over the average value of 4 with an average span of 4.59 to 5.84. These mean that there is a tendency of respondents agreed with the statement given. Islamic MFIs agree that they understand, able to identify, able to assess, and monitor risk management.
  4. 4. Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1. November 29 - 30, 2014. Hotel Putra, Kuala Lumpur, Malaysia. ISBN 978-967-11350-4-4 112 Table 1: Risk Management Practice Description Mean Std.Dev Minimum Maximum Dimension of Risk Management: Understanding of Risk Management 5.84 0.88 3 7 Risk Identification 4.59 1.22 2 7 Risk Assessment and Analysis 4.81 1.07 2 6 Risk Monitoring 5.33 0.91 4 7 Risk Management Practice: Risk Management Practice 5.44 1.01 3 7 Credit Analysis 5.55 1.31 1 7 Table 1 shows that for the dimensions of risk identification, which has the lowest average response of 4.59, had the highest standard deviation of 1.22. This indicates that the ability to perform risk identification by the Islamic- MFI lower than other risk management activities and there is a wide variation in the ability to identify risk between Islamic-MFIs. The opposite condition is indicated by the average value of the understanding dimensions of risk management at the highest average of 5.84 with a standard deviation of 0.88. On average respondents were equally likely to have a high understanding of risk management. Table 1 also shows that the respondents agreement that they implement risk management practices is high where the average of respondents' answers is 5.44 with a standard deviation of 1.01. The agreement to the statement that Islamic-MFIs perform credit analysis showed on average higher than risk management at the average 5.55, though with a wider standard deviation is 1.31. All respondent have implement risk management in spite of different understanding and different emphasis of risk management activities. Table 2: The Relationship of Risk Management Dimensions and Risk Management Practice Level of Risk Management Practice Understanding Identification Asssessment Monitoring Low (mean=4.67) 5.25 4.40 3.75 4.58 Middle-Low (mean=5.39) 5.75 4.80 5.04 5.42 Middle-High (mean=5.61) 6.09 4.20 5.36 5.54 High (mean=6.08) 6.25 4.95 5.11 5.79 Univariate analysis is then performed to rank the level of risk management practices into four groups with each group consist of 4 respondents from low to high. Through this ranking, the evaluation of the average response for each dimension of the measurement is compared. Table 2 shows that the average response for dimension of understanding increased from low to high risk group practice management. Increasing understanding of risk management has increased the level of risk management practices performed Islamic-MFI. The same relationship is also seen in the dimensions of assessment and monitoring. On the dimension of risk identification, the average response rate is not consistently shown an increase. These results indicate that the ability to understand, carry out assessment, and monitoring of risk management are related to risk management practices in the observed sample. While the ability to identify risk management showed no relationship with the risk management practice.
  5. 5. Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1. November 29 - 30, 2014. Hotel Putra, Kuala Lumpur, Malaysia. ISBN 978-967-11350-4-4 113 Table 3: The Relationship of Risk Management Dimensions and Credit Analysis Level of Risk Management Practice Understanding Identification Asssessment Monitoring Low (mean=4.71) 5.25 4.10 3.68 4.67 Middle-Low (mean=5.11) 5.66 4.95 4.57 4.96 Middle-High (mean=5.68) 6.09 4.20 5.36 5.54 High (mean=6.71) 6.34 5.10 5.64 6.17 In Table 3, the same analysis was also carried out with the consent of the respondents rank the credit analysis. Consistent with the answer on the relationship between risk management practices and dimensions of understanding, assessing, and monitoring risk management, the increase in these dimensions also increase the credit analysis performed. As for risk identification, analysis showed no relationship with credit. Inconsistent results on the identification of risk indicates that there is still a shortage of Islamic-MFI staffs skills in identifying the risks faced by their business. The inability to perform this activity may result in the incapabiity to identify potential threats to their business. Management of Islamic-MFIs need to improve the skills of their staff in risk identification periodically, so that they do not dwell only on the risk that they understand it, but also the threat of potential risks they could not identify. Given the vital role of MFIs in the community, especially for SMEs, it is government or policy makers that should encourage the improvement of Islamic-MFIs’ ability and skills in risk identification. Table 4: Perception of Risk Type Faced by Islamic-MFI Risk Types Faced by Islamic-MFI No. I-MFI Credit Risk 15 Operational Risk 10 Liquidity Risk 9 Legal Risk 1 Debt Risk 13 Interest Rate Risk 8 Reputation Risk 9 Price Risk 4 Strategic Risk 2 Competition Risk 2 Based on the results of the Islamic-MFI respondents about the type of risks they faced, average respondents were able to identify that credit risk, debt risk, liquidity risk, reputation risk, and interest rate risk is the risk faced by their businesses. Number of Islamic-MFI stated that they face credit risk, credit risk, liquidity risk, reputation risk, interest rate risk, sequantially, are 15, 13, 9, 9, and 9 respondents. The other type of risks are less ignored. They are price risk, strategy risk, competition risk and legal risk. This condition is related to the ability of risk identification, where some risks not yet be considered to affect the business of Islamic-MFIs. As rapid increase in the number of MFIs, price risk, strategic risk, and competition risk can be more important that they can ruin their business conditions. In addition, when there are changes in govement regulations, the impact of legal risk will increase. Policy makers need to prepare these MFIs given their importance for community's economy, particularly in support of SMEs who often use their services to finance the business. Moreover, in 2015 the regulatory changes and the implementation of the ASEAN free trade area will encorage Islamic-MFI to make large adjustment of some complience issue and competition strategy. Development through training and seminars can be done to boost the importance of the understanding and capabilities of risk management. Guidance in the form of the legal rules and the necessary operating standards are needed so that they are able to survice and continuously supporting the community.
  6. 6. Proceeding - Kuala Lumpur International Business, Economics and Law Conference Vol. 1. November 29 - 30, 2014. Hotel Putra, Kuala Lumpur, Malaysia. ISBN 978-967-11350-4-4 114 Coaching in providing an overview of the competitive landscape and regulatory changes necessary to keep them competitive. CONCLUSION This study aimed to investigate whether the Islamic-MFIs have implemented risk management practices and to identify what types of risks faced by BMT and KJKS. The conclusion of this study are as follows: 1. Average Islamic-MFI shows that they have understood, is able to measure and monitor risk management. However, the ability to perform risk identification by the Islamic-MFIs are still weak compared to other risk management activities. 2. The observed Islamic-MFIs have implemented risk management practices and credit analysis. 3. There are relationships between ability to understand, carry out assessment, and monitoring of risk management and risk management practices in the observed sample, but not for the dimension of risk identification. 4. The increase in the ability to understand, carry out assessment, and monitoring of risk management, also increase the credit analysis performed, but not for the dimension of risk identification. 5. Risks type that perceived by Islamic-MFI indicate their view that credit risk, debt risk, liquidity risk, reputation risk, and interest rate risk is the prominent risk faced by their businesses, but not for other risks, such as price risk, strategic risk, competition risk, legal risk. This study has implications both Islamic-MFI management and policy makers in order to further enhance the ability of MFIs in conducting risk management, especially in support of SMEs in the society. As it is known that the sustainability to face global competition and global crisis is depent on the economic fundamentals of the economy of the society. REFERENCES Bank Indonesia. (2011). Penerapan Manajemen Risiko bagi Bank Umum Syariah dan Unit Usaha Syariah. Peraturan Bank Indonesia No 13/23/2011. Cooper dan Schindler. (2006). Bussines Research Methods 9th Ed. McGraw-Hill International Edition. Ferdinand. (2006). Metode Penelitian Manajemen: Pedoman Penelitian Untuk Penulisan Skripsi, Tesis dan Disertasi Ilmu Manajemen, Badan Penerbit Universitas Diponegoro, Semarang. Hanafi. (2009) Manajemen Risiko: 2nd Ed., Yogyakarta: UPP STIM YKPN. Sekaran, U. (2006). Research Methods For Business, 4th Ed, Book 1 & 2, Jakarta: Salemba Empat. Al Tamimi and Al Mazrooei. (2007). Banks’ risk management: a comparison study of UAE national and foreign banks. The Journal of Risk Finance. Vol. 8 No. 4, 2007. pp. 394-409 Shafique, O., Hussain, N., Hassan, M.T. (2013) Differences in the risk management practices of Islamic versus conventional financial institutions in Pakistan: An empirical study, The Journal of Risk Finance, Vol. 14 Iss: 2, pp.179 - 196 Tafri, F.H., Rahman, R.A., and Omar, N. (2011). Empirical evidence on the risk management tools practised in Islamic and conventional banks, Qualitative Research in Financial Markets, Vol. 3 Iss: 2, pp.86 – 104 Khalid, S., and Amjad, S. (2012) Risk management practices in Islamic banks of Pakistan, The Journal of Risk Finance, Vol. 13 Iss: 2, pp.148 – 159.

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